Question

A company currently pays a dividend of $1 per share (D₀ = $1). It is estimated that the company's dividend will grow at a rate of 17% per year for the next 2 years, and then at a constant rate of 5% thereafter. The company's stock has a beta of 1.6, the risk-free rate is 7%, and the market risk premium is 3%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Calculation of Current Price of stock:

[Where,

P₀ = Current Price of Stock

D₀ = Current Dividend Paid = $1

g₁ = growth rate for first two years

g₂= growth rate after two years

K_e =Cost of Capital = Investor's expectation = 11.8 %   (working note )]

P₀ = 19.0526675785 or = $ 19.05

Working Note:

1. Calculation Of Discount Rate / Cost of Capital (K_e):

Using capital Asset Pricing Model :

[Where,

R_f = Risk Free rate of return

Beta = Market Risk

Rm - Rf = Market Risk Premium]

K_e = 0.118 = 11.8 %